To savvy investment strategist William Rhodes, the wave of bearishness permeating Wall Street is not only excessive, it could set the stage for a robust rally that could push stocks to a new 2005 high, possibly by Labor Day.

His belief that there will be a surge in stocks is largely based on the NYSE’s record short interest (a bet that stock prices will fall, not rise) in May of nearly 8.57 billion shares. It’s the third consecutive month in which the short interest climbed to an all-time high, and in each of these months, it has exceeded 8.4 billion shares.

Why a rally? “Because I don’t think things are all that bad,” observes Mr. Rhodes, a former investment strategist at Merrill Lynch who heads Rhodes Analytics, a Boston-based firm that doles out investment advice to institutional clients. He notes that many clients are skeptical of the economy and its ability to move forward even though it’s growing at a 3.6% rate after inflation, which, he observes, is not bad.

“Sure, we’re late in the cycle,” he said. “But earnings aren’t shrinking; they’re just not growing as fast as in the past.” Likewise, he feels, earnings growth – around 15%-16% annually – is still reasonably impressive.

Mr. Rhodes thinks a number of events could trigger sizable short covering, setting off a rally. Chief among them:

* If the Federal Reserve were to stop hiking interest rates. Bizarrely, this could be precipitated by the failure of a hedge fund.

* If the leadership of Iraq got its act together and we started pulling troops out of the country.

* If we were to kill or capture Osama bin Laden.

* If margins, which peaked in February of last year at 8.38%, stopped contracting.

* Better-than-expected earnings.

* A rally in technology stocks.

Mr. Rhodes also points to the overwhelming negative sentiment among money managers (usually a good contrary indicator).

Mr. Rhodes said attention should be paid to “the most dangerous shorts” in the market. This is not based on the number of shares of a company that has been sold short, but on the short interest as a percentage of the stock’s float. Not surprisingly, airlines, dubbed in some quarters as the “walking dead,” are conspicuous on this list, as are tech stocks and builders of homes and mobile homes.

Here’s the Big Board’s 10 most dangerous shorts (with the short interest ratio in parentheses): Krispy Kreme Doughnuts (53.9%); Calpine (47.5%); Great Atlantic & Pacific Tea (44.7%); American Italian Pasta (44.1%); Oca (43.6%); Salton (43.2%); Build-A-Bear Workshop (42.4%); Superior Industries (37.8%); Pre-Paid Legal Services (36.6%); and Action Performance (36%).